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Deal on Fiscal Cliff Could Start With AMT

An expansion in the reach of the alternative minimum tax is the element of the U.S. fiscal cliff with the largest immediate effect on taxpayers and the most bipartisan appetite for a solution, creating the possibility that lawmakers could use it to propel Congress toward a deal.

If Congress doesn’t act to prevent the $92 billion tax increase, the number of households facing the alternative tax would increase to 32.9 million from 4.4 million, according to the Internal Revenue Service. That’s an average unanticipated tax increase of about $2,800.

The effect from the AMT, as the parallel tax is known, would be immediate in early 2013 because Congress hasn’t addressed the change for tax year 2012, and taxpayers start filing returns in January. A retroactive AMT change is much more cumbersome than retroactive changes in the 2013 income tax rates, which can be handled through paycheck-withholding adjustments, said Kenneth Kies, a Republican tax lobbyist in Washington.

“The IRS would be paralyzed, not to mention the fact that the taxpayers wouldn’t get the joke,” said Kies, a Republican tax lobbyist in Washington. “This just has to be done in December.’

The AMT isn’t indexed for inflation, meaning that Congress must routinely pass so-called patches to keep it from reaching deep into the middle class. Congress could pass the patch without any other items attached; this year, at least for now, it’s linked to the fight over fiscal policy at the center of the political campaign.

The House and Senate have passed AMT patches for 2012. The House bill tied the minimum-tax provision to extensions of income-tax cuts for taxpayers at all income levels, which is a non-starter for Senate Democrats. The Senate bill doesn’t extend the tax cuts for top earners beyond 2012, so it won’t advance in the Republican-led House.

Each side is trying to gain leverage by threatening to go over the $607 billion fiscal cliff of automatic spending cuts and tax increases scheduled to take effect in January. The Congressional Budget Office estimates that failure to act would cause a recession.

“You go through this and there’s pain in every direction, and it’s why it was designed to be this way,” Senator Richard Durbin of Illinois said in an interview at the Democratic National Convention in Charlotte, North Carolina on Sept. 6. “How in the world do you move the Congress off of its current impotence into something that works? You’ve got to have looming over your head Doomsday, and that’s what the cliff’s all about.”

Congress Returns

The AMT is one of several urgent issues Congress faces as it returns to Washington this week after its summer break. Lawmakers have a Sept. 30 deadline to pass a stopgap measure to fund government operations for six months in the new fiscal year, which congressional leaders and Obama tentatively agreed to in July.

Tea Party-backed Republicans dropped their demand for less spending than the $1.047 trillion budget in a 2011 law that raised the federal debt ceiling, leading to the agreement.

By Oct. 1, Congress also needs to renew farm programs and help the U.S. Postal Service pay for retiree health care. Lawmakers also left Washington for a five-week recess without providing drought aid to ranchers or acting to protect computers against cyber-attacks.

Congress created the forerunner of the AMT in 1969, in response to reports that 155 people earned more than $200,000 and legally didn’t pay any taxes.

The idea of making sure high-income people couldn’t avoid taxes was simple. The execution wasn’t.

After reaching its current form in 1986, the AMT now operates as a parallel tax system, requiring taxpayers to calculate their liability under both systems and pay the higher amount. Because the AMT limits taxpayers from taking personal exemptions and deducting state and local taxes, it disproportionately affects people with many exemptions or who live in high-tax states.

The states with the highest concentrations of AMT payers in 2009 were New Jersey, New York and Connecticut. About 9 percent of taxable returns from New Jersey residents include the AMT. At the bottom of the list are Alaska, South Dakota and Tennessee.

Lawmakers haven’t been willing to repeal it because revenue from the tax is assumed in future budgets.

Most of the taxpayers who would owe AMT if Congress doesn’t act have no idea that the refunds they’re counting on would be smaller or disappear, said John Buckley, the former chief tax counsel for Democrats on the House Ways and Means Committee.

‘Unpleasant Surprise’

“It has to be resolved in some way this year,” said Buckley, who now teaches at Georgetown University’s law school. “It would be a real unpleasant surprise if it actually lapsed.”

In August, the Senate Finance Committee approved a $205 billion tax bill that would patch the AMT for 2012 and 2013 and extend dozens of other tax breaks, including benefits for corporate research and teachers’ out-of-pocket expenses.

Such a piecemeal approach to the fiscal cliff is turning it into more of a slope, Senator Charles Schumer, a New York Democrat, said at the time. That strategy would separate the AMT from all of the other items.

Senate Democrats may bring that bill to the floor this month. House Republicans have said that they don’t plan to act on the miscellaneous tax breaks until after the Nov. 6 election.

The pressing concern over the AMT will drive the parties toward a compromise in November and December, said Jon Traub, managing principal of tax policy at Deloitte Tax LLP in Washington.

Addressing the 2012 AMT in 2013 would require delaying the tax filing season or forcing people to file millions of amended tax returns.

“It seems like that’s a very hard problem to solve retroactively,” said Traub, a former staff director for the Ways and Means Committee under Republican Dave Camp.

In previous years, the IRS has warned lawmakers that late action on the AMT and other expiring breaks could delay the start of the tax-filing season, and that’s what happened in early 2011 after lawmakers waited until December to extend expiring provisions.

Congress won’t let the AMT patch lapse, because it would be too damaging to taxpayers, said Leonard Burman, who studies tax policy at Syracuse University in New York.

“I’d bet my $4,000 AMT bill that Congress will fix this before I actually have to file my tax return,” he said. “Nobody wants to put a huge tax increase on swing voters right now.”

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